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Document and Entity Information
6 Months Ended
Jan. 31, 2011
Document and Entity Information
Document Type 10-Q
Amendment Flag false
Document Period End Date Jan 31, 2011
Document Fiscal Year Focus 2011
Document Fiscal Period Focus Q2
Entity Registrant Name DONALDSON CO INC
Entity Central Index Key 0000029644
Current Fiscal Year End Date --07-31
Entity Filer Category Large Accelerated Filer
Entity Common Stock, Shares Outstanding 76,911,778
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CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS (USD  $)
In Thousands, except Share data
3 Months Ended 6 Months Ended
Jan. 31, 2011
Jan. 31, 2010
Jan. 31, 2011
Jan. 31, 2010
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
Net sales  $ 537,105  $ 436,122  $ 1,074,014  $ 864,202
Cost of sales 347,562 290,175 696,381 569,855
Gross margin 189,543 145,947 377,633 294,347
Operating expenses 122,102 106,896 235,689 202,852
Operating income, net 67,441 39,051 141,944 91,495
Interest expense 2,936 2,795 6,589 5,745
Other income, net (3,502) (1,281) (4,609) (1,801)
Earnings before income taxes 68,007 37,537 139,964 87,551
Income taxes 23,428 6,571 42,251 22,016
Net earnings  $ 44,579  $ 30,966  $ 97,713  $ 65,535
Weighted average shares - basic 77,580,064 78,087,356 77,375,086 78,066,774
Weighted average shares - diluted 78,977,509 79,406,326 78,766,895 79,375,443
Net earnings per share - basic  $ 0.57  $ 0.4  $ 1.26  $ 0.84
Net earnings per share - diluted  $ 0.56  $ 0.39  $ 1.24  $ 0.83
Dividends paid per share  $ 0.13  $ 0.115  $ 0.225  $ 0.23
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CONDENSED CONSOLIDATED BALANCE SHEETS (USD  $)
In Thousands
Jan. 31, 2011
Jul. 31, 2010
Assets
Cash and cash equivalents  $ 219,635  $ 232,000
Short-term investments 66,494
Accounts receivable, less allowance of  $6,509 and  $6,315 376,321 358,917
Inventories 230,709 203,631
Prepaids and other current assets 65,211 65,667
Total current assets 958,370 860,215
Property, plant and equipment, at cost 913,501 876,758
Less accumulated depreciation (542,271) (510,866)
Property, plant and equipment, net 371,230 365,892
Goodwill 168,214 165,315
Intangible assets, net 55,939 58,292
Other assets 41,354 49,792
Total assets 1,595,107 1,499,506
Liabilities and shareholders' equity
Short-term borrowings 29,330 50,000
Current maturities of long-term debt 46,710 5,536
Trade accounts payable 178,926 165,907
Other current liabilities 162,911 167,813
Total current liabilities 417,877 389,256
Long-term debt 211,965 256,192
Deferred income taxes 6,752 7,076
Other long-term liabilities 81,910 100,349
Total liabilities 718,504 752,873
Shareholders' equity
Preferred stock,  $1.00 par value, 1,000,000 shares authorized, none issued    
Common stock,  $5.00 par value, 120,000,000 shares authorized, 88,643,194 shares issued 443,216 443,216
Retained earnings 820,930 744,247
Stock compensation plans 23,222 22,326
Accumulated other comprehensive loss (7,048) (40,486)
Treasury stock at cost, 11,641,708 and 12,222,381 shares at January 31, 2011 and July 31, 2010, respectively (403,717) (422,670)
Total shareholders' equity 876,603 746,633
Total liabilities and shareholders' equity  $ 1,595,107  $ 1,499,506
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CONDENSED CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD  $)
In Thousands, except Share data
Jan. 31, 2011
Jul. 31, 2010
CONDENSED CONSOLIDATED BALANCE SHEETS
Accounts receivable, allowance  $ 6,509  $ 6,315
Preferred stock, share par value  $ 1  $ 1
Preferred stock, shares authorized 1,000,000 1,000,000
Preferred stock, shares issued 0 0
Common stock, share par value  $ 5  $ 5
Common stock, shares authorized 120,000,000 120,000,000
Common stock, shares issued 88,643,194 88,643,194
Treasury stock, shares 11,641,708 12,222,381
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (USD  $)
In Thousands
6 Months Ended
Jan. 31, 2011
Jan. 31, 2010
Operating Activities
Net earnings  $ 97,713  $ 65,535
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization 30,478 30,549
Changes in operating assets and liabilities (19,947) (6,696)
Tax benefit of equity plans (7,445) (2,375)
Stock compensation plan expense 6,089 5,745
Deferred taxes 5,784 3,438
Other, net (19,612) (10,925)
Net cash provided by operating activities 93,060 85,271
Investing Activities
Net expenditures on property and equipment (24,051) (18,121)
Purchase of short-term investments (66,494)
Acquisitions and divestitures 3,613 (250)
Net cash used in investing activities (86,932) (18,371)
Financing Activities
Purchase of treasury stock (6,491) (8,887)
Proceeds from settlement of interest rate swap 4,710
Repayments of long-term debt (5,294) (5,255)
Change in short-term borrowings (20,670) (3,743)
Dividends paid (19,542) (17,792)
Tax benefit of equity plans 7,445 2,375
Exercise of stock options 12,113 3,443
Net cash used in financing activities (27,729) (29,859)
Effect of exchange rate changes on cash 9,236 (122)
Increase (Decrease) in cash and cash equivalents (12,365) 36,919
Cash and cash equivalents, beginning of year 232,000 143,687
Cash and cash equivalents, end of period  $ 219,635  $ 180,606
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Basis of Presentation
6 Months Ended
Jan. 31, 2011
Basis of Presentation
Basis of Presentation

Note A – Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Donaldson Company, Inc. and its subsidiaries (the Company) have been prepared in accordance with generally accepted accounting principles in the United States of America (U.S. GAAP) and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal recurring nature. Operating results for the three and six month periods ended January 31, 2011 are not necessarily indicative of the results that may be expected for future periods. The year-end condensed balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. For further information, refer to the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K/A for the year ended July 31, 2010.

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Short-Term Investments
6 Months Ended
Jan. 31, 2011
Short-Term Investments
Short-Term Investments

Note B – Short-Term Investments

Short – Term Investments Classification of the Company's investments as current or non-current is dependent upon management's intended holding period, the investment's maturity date and liquidity considerations based on market conditions. If management intends to hold the investments for longer than one year as of the balance sheet date, they are classified as non-current.

All short-term investments have maturities in excess of three months but not more than six months. There were no short-term investments as of July 31, 2010. The following is a summary of amounts recorded on the Consolidated Balance Sheet for the Company's short-term investments as of January 31, 2011 (thousands of dollars):

 

 

 

 

 

 

 

January 31,
2011

 

Certificates of deposit

 

 $

41,130

 

Commercial Paper

 

 

25,364

 

Total Short-term investments

 

 $

66,494

 

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Inventories
6 Months Ended
Jan. 31, 2011
Inventories
Inventories

Note C – Inventories

          The components of inventory as of January 31, 2011 and July 31, 2010 are as follows (thousands of dollars):

 

 

 

 

 

 

 

 

 

 

January 31,
2011

 

July 31,
2010

 

Materials

 

 $

87,758

 

 $

79,371

 

Work in process

 

 

26,337

 

 

23,163

 

Finished products

 

 

116,614

 

 

101,097

 

Total inventories

 

 $

230,709

 

 $

203,631

 

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Accounting for Stock-Based Compensation
6 Months Ended
Jan. 31, 2011
Accounting for Stock-Based Compensation
Accounting for Stock-Based Compensation

Note D – Accounting for Stock-Based Compensation

          Stock-based employee compensation cost is recognized using the fair-value based method for all awards. The Company determined the fair value of its option awards using the Black-Scholes option pricing model. The following assumptions were used to value the options, including reload options which generally have a shorter contractual life, granted during the six months ended January 31, 2011: range of 8 days to 8 years expected life; expected volatility range of 25.5 percent to 34.7 percent; risk-free interest rate range of 0.12 percent to 3.1 percent; and annual dividend yield of 1.0 percent. The expected life selected for options granted during the period represents the period of time that the options are expected to be outstanding based on the contractual life and historical data of option holder exercise and termination behavior. Expected volatilities are based upon historical volatility of the Company's stock over a period at least equal to the expected life of each option grant. Option grants are priced at the fair market value of the Company's stock on the date of grant. The weighted average fair value for options granted during the six months ended January 31, 2011 and 2010 was  $17.26 per share and  $13.31 per share, respectively. For the three and six months ended January 31, 2011, the Company recorded pretax compensation expense associated with stock options of  $4.0 million and  $4.8 million, respectively, and recorded  $1.5 million and  $1.8 million of related tax benefit. For the three and six months ended January 31, 2010, the Company recorded pretax compensation expense associated with stock options of  $5.0 million and  $5.3 million, respectively, and recorded  $1.9 million and  $2.0 million of related tax benefit.

          The following table summarizes stock option activity during the six months ended January 31, 2011:

 

 

 

 

 

 

 

 

 

 

Options
Outstanding

 

Weighted
Average
Exercise
Price

 

Outstanding at July 31, 2010

 

 

4,771,812

 

 $

30.04

 

Granted

 

 

551,601

 

 

57.22

 

Exercised

 

 

(853,576

)

 

22.11

 

Canceled

 

 

(4,249

)

 

44.32

 

Outstanding at January 31, 2011

 

 

4,465,588

 

 

34.90

 

          The total intrinsic value of options exercised during the six months ended January 31, 2011 and 2010 was  $24.9 million and  $9.5 million, respectively.

          The following table summarizes information concerning outstanding and exercisable options as of January 31, 2011:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Range of Exercise Prices

 

Number
Outstanding

 

Weighted
Average
Remaining
Contractual
Life (Years)

 

Weighted
Average
Exercise
Price

 

Number
Exercisable

 

Weighted
Average
Exercise
Price

 

 $12 to  $22

 

 

776,516

 

 

1.60

 

 $

17.93

 

 

776,516

 

 $

17.93

 

 $22 to  $32

 

 

1,160,725

 

 

3.42

 

 

30.13

 

 

1,144,647

 

 

30.11

 

 $32 to  $42

 

 

1,209,289

 

 

5.91

 

 

34.86

 

 

1,188,767

 

 

34.86

 

 $42 and above

 

 

1,319,058

 

 

8.73

 

 

49.14

 

 

658,451

 

 

44.31

 

 

 

 

4,465,588

 

 

5.35

 

 

34.90

 

 

3,768,381

 

 

31.58

 

          At January 31, 2011, the aggregate intrinsic value of options outstanding and exercisable was  $103.4 million and  $99.7 million, respectively.

          As of January 31, 2011, there was  $7.8 million of total unrecognized compensation cost related to non-vested stock options granted under the 2001 and 2010 Master Stock Incentive Plans. This unvested cost is expected to be recognized during the remainder of Fiscal Years 2011, 2012, 2013 and 2014.

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Net Earnings Per Share
6 Months Ended
Jan. 31, 2011
Net Earnings Per Share
Net Earnings Per Share

Note E – Net Earnings Per Share

          The Company's basic net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares. The Company's diluted net earnings per share is computed by dividing net earnings by the weighted average number of outstanding common shares and common equivalent shares relating to stock options and stock incentive plans. Certain outstanding options were excluded from the diluted net earnings per share calculations because their exercise prices were greater than the average market price of the Company's common stock during those periods. For the three and six months ended January 31, 2011, there were 495,533 options and 505,396 options excluded from the diluted net earnings per share calculation, respectively. For the three and six months ended January 31, 2010, there were 807,296 options and 995,046 options excluded from the diluted net earnings per share calculation, respectively.

          The following table presents information necessary to calculate basic and diluted net earnings per common share (thousands, except per share amounts):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
January 31,

 

Six Months Ended
January 31,

 

 

 

2011

 

2010

 

2011

 

2010

 

Weighted average shares - basic

 

 

77,580

 

 

78,087

 

 

77,375

 

 

78,067

 

Common share equivalents

 

 

1,398

 

 

1,319

 

 

1,392

 

 

1,308

 

Weighted average shares - diluted

 

 

78,978

 

 

79,406

 

 

78,767

 

 

79,375

 

Net earnings for basic and diluted earnings per share computation

 

 $

44,579

 

 $

30,966

 

 $

97,713

 

 $

65,535

 

Net earnings per share - basic

 

 $

0.57

 

 $

0.40

 

 $

1.26

 

 $

0.84

 

Net earnings per share - diluted

 

 $

0.56

 

 $

0.39

 

 $

1.24

 

 $

0.83

 

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Shareholders' Equity
6 Months Ended
Jan. 31, 2011
Shareholders' Equity
Shareholders' Equity

Note F – Shareholders' Equity

          The Company reports accumulated other comprehensive loss as a separate item in the shareholders' equity section of the balance sheet.

          Total comprehensive income and its components are as follows (thousands of dollars):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
January 31,

 

Six Months Ended
January 31,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net earnings

 

 $

44,579

 

 $

30,966

 

 $

97,713

 

 $

65,535

 

Foreign currency translation adjustment

 

 

(3,670

)

 

(18,306

)

 

32,102

 

 

(3,025

)

Realization upon sale of business

 

 

(101

)

 

 

 

(101

)

 

 

Net gain (loss) on hedging derivatives, net of deferred taxes

 

 

389

 

 

197

 

 

134

 

 

314

 

Pension and postretirement liability adjustment, net of deferred taxes

 

 

1,444

 

 

574

 

 

1,303

 

 

1,144

 

Total comprehensive income

 

 $

42,641

 

 $

13,431

 

 $

131,151

 

 $

63,968

 

          Total accumulated other comprehensive loss (OCL) and its components at January 31, 2011 and July 31, 2010 are as follows (thousands of dollars):

 

 

 

 

 

 

 

 

 

 

January 31,
2011

 

July 31,
2010

 

Foreign currency translation adjustment

 

 $

91,195

 

 $

59,194

 

Net loss on hedging derivatives, net of deferred taxes

 

 

(328

)

 

(462

)

Pension and postretirement liability, net of deferred taxes

 

 

(97,915

)

 

(99,218

)

Total accumulated other comprehensive loss

 

 $

(7,048

)

 $

(40,486

)

          The Company's Board of Directors authorized the repurchase of 8.0 million shares of common stock on March 26, 2010. During the three months ended January 31, 2011 the Company did not repurchase any shares. During the six months ended January 31, 2011, the Company repurchased 149,994 shares for  $6.5 million at an average price of  $43.27 per share. As of January 31, 2011 the Company had remaining authorization to repurchase up to 6.8 million shares pursuant to the current authorization.

          On January 28, 2011, the Company's Board of Directors declared a cash dividend in the amount of  $0.13 per common share payable to stockholders of record on February 25, 2011. The dividend will be paid on March 18, 2011.

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Segment Reporting
6 Months Ended
Jan. 31, 2011
Segment Reporting
Segment Reporting

Note G – Segment Reporting

          The Company has two reportable segments, Engine Products and Industrial Products, that have been identified based on the Company's internal organization structure, management of operations, and performance evaluation. Corporate and Unallocated includes corporate expenses determined to be non-allocable to the segments and interest income and expense. The Company is an integrated enterprise, characterized by substantial intersegment cooperation, cost allocations, and sharing of assets. Therefore, the Company does not represent that these segments, if operated independently, would report the operating profit and other financial information shown below. Segment detail and reclassification adjustments are summarized as follows (thousands of dollars):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Engine
Products

 

Industrial
Products

 

Corporate &
Unallocated

 

Total
Company

 

Three Months Ended January 31, 2011:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 $

331,122

 

 $

205,983

 

 $

 

 $

537,105

 

Earnings before income taxes

 

 

44,203

 

 

29,127

 

 

(5,323

)

 

68,007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended January 31, 2010:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 $

256,423

 

 $

179,699

 

 $

 

 $

436,122

 

Earnings before income taxes

 

 

27,256

 

 

14,293

 

 

(4,012

)

 

37,537

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended January 31, 2011:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 $

664,891

 

 $

409,123

 

 $

 

 $

1,074,014

 

Earnings before income taxes

 

 

92,654

 

 

59,162

 

 

(11,852

)

 

139,964

 

Assets

 

 

779,080

 

 

482,014

 

 

334,013

 

 

1,595,107

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended January 31, 2010:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 $

507,749

 

 $

356,453

 

 $

 

 $

864,202

 

Earnings before income taxes

 

 

59,298

 

 

35,487

 

 

(7,234

)

 

87,551

 

Assets

 

 

652,540

 

 

474,479

 

 

247,435

 

 

1,374,454

 

          For the three and six months ended January 31, 2010, net sales reflect the reclassification of  $6,773 and  $14,127, respectively, earnings before income taxes reflect a reclassification of  $700 and  $1,842, respectively, and assets reflect a reclassification of  $27,099 as of January 31, 2010, as a result of an internal reorganization of Industrial Hydraulics from Industrial Products to Engine Products, which became effective August 1, 2010.

          The Industrial Products segment incurred  $0.7 million of restructuring expenses during the three months ended October 31, 2010. There were no restructuring expenses incurred during the three months ended January 31, 2011. The Engine Products and Industrial Products segments incurred  $0.5 million and  $4.6 million of restructuring expenses for the three months ended January 31, 2010, respectively, and  $1.4 million and  $5.0 million of restructuring expenses for the six months ended January 31, 2010, respectively.

          There were no Customers over 10 percent of net sales for the three or six months ended January 31, 2011 and 2010. There was one Customer over 10 percent of gross accounts receivable as of January 31, 2011. There were no Customers over 10 percent of gross accounts receivable as of January 31, 2010.

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Goodwill and Other Intangible Assets
6 Months Ended
Jan. 31, 2011
Goodwill and Other Intangible Assets
Goodwill and Other Intangible Assets

Note H – Goodwill and Other Intangible Assets

          Goodwill is assessed for impairment between annual assessments whenever events or circumstances make it more likely than not that an impairment may have occurred. The Company's most recent annual impairment assessment for goodwill was completed during the third quarter of Fiscal 2010. The results of this assessment showed that the fair values of the reporting units to which goodwill is assigned continue to substantially exceed the book values of the respective reporting units, resulting in no goodwill impairment. As of August 1, 2010, as a result of an internal reorganization, the Company transferred Industrial Hydraulics, a component of its Industrial Filtration Solutions Products within the Industrial Products segment to After markets Products within the Engine Products segment, along with the goodwill associated with this component. Following is a reconciliation of goodwill for the six months ending January 31, 2011 (thousands of dollars):

 

 

 

 

 

 

 

 

 

 

 

 

 

Engine
Products

 

Industrial
Products

 

Total Goodwill

 

Balance as of July 31, 2010

 

 $

60,914

 

 $

104,401

 

 $

165,315

 

Goodwill reclassified

 

 

11,258

 

 

(11,258

)

 

 

Disposition activity

 

 

 

 

(325

)

 

(325

)

Foreign exchange translation

 

 

388

 

 

2,836

 

 

3,224

 

Balance as of January 31, 2011

 

 $

72,560

 

 $

95,654

 

 $

168,214

 

          Dispositions of goodwill during the quarter relate to the sale of its Ultracool chiller business, based in Terrassa, Spain for  $3.6 million, which resulted in a gain on sale of  $0.4 million. The Ultracool chiller business manufactured industrial circulation chillers and was part of the Company's Industrial Products segment.

          As of January 31, 2011, other intangible assets were  $55.9 million, a  $2.4 million decrease from the balance of  $58.3 million at July 31, 2010. The decrease in other intangible assets is due to amortization of existing assets of  $2.9 million which was offset by a  $0.5 million increase due to foreign exchange translation. There were no intangible asset additions during the six months ended January 31, 2011.

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Guarantees
6 Months Ended
Jan. 31, 2011
Guarantees
Guarantees

Note I – Guarantees

          The Company and Caterpillar Inc. equally own the shares of Advanced Filtration Systems Inc. (AFSI), an unconsolidated joint venture, and guarantee certain debt of the joint venture. As of January 31, 2011 the joint venture had  $25.0 million of outstanding debt of which the Company guarantees half. For the three and six months ended January 31, 2011, the Company recorded  $0.7 million and  $0.9 million of earnings for this equity method investment, respectively. The Company recorded  $0.2 million of earnings for this equity method investment during both the three and six months ended January 31, 2010. During the three and six months ended January 31, 2011 and 2010, the Company also recorded royalty income of  $1.6 million and  $3.3 million, respectively, and  $1.3 million and  $2.5 million, respectively, related to AFSI.

          At January 31, 2011, the Company had a contingent liability for standby letters of credit totaling  $20.0 million that have been issued and are outstanding. The letters of credit guarantee payment to third parties in the event the Company is in breach of a specified bond financing agreement and insurance contract terms as detailed in each letter of credit. At January 31, 2011, there were no amounts drawn upon these letters of credit.

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Warranty
6 Months Ended
Jan. 31, 2011
Warranty
Warranty

Note J – Warranty

          The Company estimates warranty costs using standard quantitative measures based on historical warranty claim experience and evaluation of specific Customer warranty issues. Following is a reconciliation of warranty reserves for the six months ended January 31, 2011 and 2010 (thousands of dollars):

 

 

 

 

 

 

 

 

 

 

January 31,

 

 

 

2011

 

2010

 

Beginning balance

 

 $

15,707

 

 $

9,215

 

Accruals for warranties issued during the reporting period

 

 

3,436

 

 

3,702

 

Accruals related to pre - existing warranties (including changes in estimates)

 

 

2,367

 

 

(873

)

Less settlements made during the period

 

 

(4,342

)

 

(1,775

)

Ending balance

 

 $

17,168

 

 $

10,269

 

          The increase in warranty accruals is primarily due to a specific warranty matter in the Company's Retrofit Emissions Products group. An expense of  $1.5 million was recorded, net of supplier recoveries, for this matter during the first six months of Fiscal 2011.

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Employee Benefit Plans
6 Months Ended
Jan. 31, 2011
Employee Benefit Plans
Employee Benefit Plans

Note K – Employee Benefit Plans

          The Company and certain of its international subsidiaries have defined benefit pension plans for many of their hourly and salaried employees. There are two types of domestic plans. The first type of domestic plan is a traditional defined benefit pension plan primarily for production employees. The second is a plan for salaried workers that provides defined benefits pursuant to a cash balance feature whereby a participant accumulates a benefit comprised of a percentage of current salary that varies with years of service, interest credits, and transition credits. The international plans generally provide pension benefits based on years of service and compensation level.

          Net periodic pension costs for the Company's pension plans include the following components (thousands of dollars):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
January 31,

 

Six Months Ended
January 31,

 

 

 

2011

 

2010

 

2011

 

2010

 

Net periodic cost:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

 $

4,102

 

 $

3,320

 

 $

8,074

 

 $

6,638

 

Interest cost

 

 

4,851

 

 

4,923

 

 

9,661

 

 

9,845

 

Expected return on assets

 

 

(6,856

)

 

(7,157

)

 

(13,696

)

 

(14,313

)

Transition amount amortization

 

 

55

 

 

59

 

 

109

 

 

119

 

Prior service cost amortization

 

 

112

 

 

74

 

 

228

 

 

148

 

Actuarial loss amortization

 

 

842

 

 

732

 

 

1,652

 

 

1,464

 

Net periodic benefit cost

 

 $

3,106

 

 $

1,951

 

 $

6,028

 

 $

3,901

 


          The Company's general funding policy for its pension plans is to make at least the minimum contributions as required by applicable regulations. Additionally, the Company may elect to make additional contributions up to the maximum tax deductible contribution. For the six months ended January 31, 2011, the Company made contributions of  $4.6 million to its non-U.S. pension plans and a discretionary contribution of  $20.0 million to its U.S. pension plans. The Company does not currently plan to make any additional contributions to its U.S. pension plans in Fiscal 2011. The Company currently estimates that it will contribute up to an additional  $2.0 million to its non-U.S. pension plans during the remainder of Fiscal 2011.

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Financial Instruments
6 Months Ended
Jan. 31, 2011
Financial Instruments
Financial Instruments

Note L – Financial Instruments

          The Company uses forward exchange contracts to manage its exposure to fluctuations in foreign exchange rates. The Company enters into forward exchange contracts of generally less than one year to hedge forecasted transactions between its subsidiaries and to reduce potential exposure related to fluctuations in foreign exchange rates for existing recognized assets and liabilities. It also utilizes forward exchange contracts for anticipated intercompany and third-party transactions such as purchases, sales, and dividend payments denominated in local currencies. Forward exchange contracts are designated as cash flow hedges as they are designed to hedge the variability of cash flows associated with the underlying existing recognized or anticipated transactions. Changes in the value of derivatives designated as cash flow hedges are recorded in other comprehensive loss in shareholders' equity until earnings are affected by the variability of the underlying cash flows. At that time, the applicable amount of gain or loss from the derivative instrument that is deferred in shareholders' equity is reclassified to earnings. Effectiveness is measured using spot rates to value both the hedge contract and the hedged item. The excluded forward points, as well as any ineffective portions of hedges, are recorded in earnings through the same line as the underlying transaction. During the first six months of Fiscal 2011,  $0.2 million of losses were recorded due to the exclusion of forward points from the assessment of hedge effectiveness.

          These unrealized losses and gains are reclassified, as appropriate, when earnings are affected by the variability of the underlying cash flows during the term of the hedges. The Company expects to record  $0.5 million of net deferred losses from these forward exchange contracts during the next 12 months.

          The impact on accumulated other comprehensive loss and earnings from foreign exchange contracts that qualified as cash flow hedges for the six months ended January 31, 2011 and 2010 was as follows (thousands of dollars):

 

 

 

 

 

 

 

 

 

 

January 31,

 

 

 

2011

 

2010

 

Net carrying amount at beginning of year

 

 $

(660

)

 $

(650

)

Cash flow hedges deferred in other comprehensive income

 

 

(1,078

)

 

(1,162

)

Cash flow hedges reclassified to income (effective portion)

 

 

1,312

 

 

1,664

 

Change in deferred taxes

 

 

(71

)

 

(159

)

Net carrying amount at January 31

 

 $

(497

)

 $

(307

)

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Fair Values
6 Months Ended
Jan. 31, 2011
Fair Values
Fair Values

Note M – Fair Values

          The Company uses interest rate swaps to manage its exposure to changes in the fair value of its fixed-rate debt resulting from interest rate fluctuations. It is the Company's policy to enter into derivative transactions only to the extent true exposures exist; the Company does not enter into derivative transactions for speculative or trading purposes. The Company enters into derivative transactions only with counterparties with high credit ratings. These transactions may expose the Company to credit risk to the extent that the instruments have a positive fair value, but the Company has not experienced any losses, nor does the Company anticipate any material losses.

          The Company is exposed to changes in the fair value of its fixed-rate debt resulting from interest rate fluctuations. To hedge this exposure, the Company entered into three fixed-to-variable interest rate swaps for  $25 million each on December 15, 2010. These interest rate swaps are accounted for as fair value hedges. Changes in the payment of interest resulting from the interest rate swaps are recorded as a component of interest expense.

          The following summarizes the Company's fair value of outstanding derivatives at January 31, 2011 and July 31, 2010, on the Consolidated Balance Sheets (thousands of dollars):

 

 

 

 

 

 

 

 

 

 

January 31,
2011

 

July 31,
2010

 

 

 

 

 

 

 

Asset derivatives recorded under the caption Prepaids and other current assets

 

 

 

 

 

 

 

Foreign exchange contracts

 

 $

1,077

 

 $

807

 

 

 

 

 

 

 

 

 

Asset derivatives recorded under the caption Other assets

 

 

 

 

 

 

 

Interest rate swap asset

 

 $

588

 

 $

4,590

 

 

 

 

 

 

 

 

 

Liability derivatives recorded under the caption Other current liabilities

 

 

 

 

 

 

 

Foreign exchange contracts

 

 $

1,987

 

 $

2,127

 

          The Company's derivative financial instruments present certain market and counterparty risks. However, concentration of counterparty risk is mitigated as the Company deals with a variety of major banks worldwide. In addition, only conventional derivative financial instruments are utilized. The Company would not be materially impacted if any of the counterparties to the derivative financial instruments outstanding failed to perform according to the terms of its agreement. At this time, the Company does not require collateral or any other form of securitization to be furnished by the counterparties to its derivative instruments.

          The fair values of the Company's financial assets and financial liabilities listed below reflect the amounts that would be received to sell the assets or paid to transfer the liabilities in an orderly transaction between market participants at the measurement date (exit price). The fair values are based on inputs other than quoted prices that are observable for the asset or liability. These inputs include foreign currency exchange rates and interest rates. The financial assets and financial liabilities are primarily valued using standard calculations and models that use as their basis readily observable market parameters. Industry standard data providers are the primary source for forward and spot rate information for both interest rates and currency rates.

Significant Other Observable Inputs
(Level 2)*

 

 

 

January 31,
2011

 

July 31,
2010

 

Forward exchange contracts - net liability position

 

 $

(910

)

 $

(1,320

)

Interest rate swaps - net asset position

 

 

588

 

 

4,590

 


 

 

 

 

 

          * Inputs to the valuation methodology of level 2 assets include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
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Commitments and Contingencies
6 Months Ended
Jan. 31, 2011
Commitments and Contingencies
Commitments and Contingencies

Note N – Commitments and Contingencies

          The Company records provisions with respect to identified claims or lawsuits when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Claims and lawsuits are reviewed quarterly and provisions are taken or adjusted to reflect the status of a particular matter. The Company believes the recorded reserves in its consolidated financial statements are adequate in light of the probable and estimable outcomes. The recorded liabilities were not material to the Company's financial position, results of operation, or liquidity, and the Company does not believe that any of the currently identified claims or litigation will materially affect its financial position, results of operation, or liquidity.

          On March 31, 2008, S&E Quick Lube, a filter distributor, filed a lawsuit in U.S. District Court for the District of Connecticut alleging that 12 filter manufacturers, including the Company, engaged in a conspiracy to fix prices, rig bids, and allocate U.S. Customers for aftermarket automotive filters. This lawsuit seeks various remedies including injunctive relief and monetary damages of an unspecified amount and is a purported class action on behalf of direct purchasers of automotive aftermarket filters from the defendants. Parallel purported class actions, including on behalf of a variety of direct and indirect purchasers of aftermarket filters, have been filed by other plaintiffs in a variety of jurisdictions in the United States and Canada. The U.S. cases have been consolidated into a single multi-district litigation in the Northern District of Illinois. In addition, on April 16, 2009, the Attorney General of the State of Florida filed a complaint in the U.S. District Court for the Northern District of Illinois based on these same allegations. The Company will vigorously defend the claims raised in these lawsuits. The Company understands that the Antitrust Division of the Department of Justice (DOJ) was investigating the allegations raised in these suits and issued subpoenas in connection with that investigation. The Company has not been contacted by the DOJ in connection with the DOJ investigation, but public reports indicate that the DOJ officially closed that investigation in January 2010. In June 2010, the United States gave notice of its election to decline intervention in a qui tam action entitled United States of America, ex rel. William G. Burch v. Champion Laboratories, Inc. et al., which had been filed under seal in December 2009 in the United States District Court for the Northern District of Oklahoma. After that notice, the matter no longer remained under seal. In August 2010, the County of Suffolk, New York, filed a purported class action entitled County of Suffolk, New York, v. Champion Laboratories, et al., in the United States District Court for the Eastern District of New York. Both the Burch qui tam action and the Suffolk action contain allegations similar to those made in the multi-district litigation already pending in the Northern District of Illinois. The Company denies any liability in either action and intends to vigorously defend the claims raised in these lawsuits. In June 2010, the Attorney General of the State of Washington served the Company with a Civil Investigative Demand inquiring into the same issues as those raised in the complaint filed by the State of Florida. The Company is cooperating with the Washington investigation but has denied any wrongdoing.

      On May 19, 2010, the Air Resources Board for the State of California (ARB) revoked its verification of the Company's DFM Diesel Multi-Stage Filter System (DMF) for use with on-road diesel engines, for which verification was originally issued on December 16, 2005. Under the ARB revocation, the DMF system may not be sold, installed or offered for sale as an ARB verified system. The Company issued a product bulletin for its DMF product on February 8, 2010 and subsequently submitted a proposal to ARB to address a failure mode that can occur when an engine is not operating in compliance with the requirements for engine performance and temperature. On July 28, 2010, ARB issued its approval for the Company's service campaign. The Company is currently working with the Environmental Protection Agency (EPA) and state regulatory authorities regarding its field service campaign for sales outside California.

          In addition, ARB has notified the Company by letter that it may seek fines and penalties in connection with the past sales of the DMF product in California. The Company denies that any sales were made in California without ARB verification. The Company is not currently selling any DMF product and is working with the EPA and state regulatory authorities to obtain the necessary approvals. The impact of ceasing all DMF product sales is not material to our operating results or liquidity. Therefore, we do not anticipate a material adverse impact to our financial results due to the issues related to the DMF product.

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Income Taxes
6 Months Ended
Jan. 31, 2011
Income Taxes
Income Taxes

Note O – Income Taxes

          The effective tax rate for the three and six months ended January 31, 2011, was 34.4 percent and 30.2 percent, respectively. The effective tax rate for the three and six months ended January 31, 2010, was 17.5 percent and 25.1 percent, respectively. The increase in our effective tax rate for both the three and six months ending January 31, 2011, was primarily due to a  $4.0 million charge related to the reorganization of our subsidiary holdings to improve our global business and legal entity structure. This was partially offset by  $0.9 million in tax benefits primarily from the retroactive reinstatement of the Research and Experimentation Credit in the United States. For the six months ending January 31, 2011, the net of discrete tax expense items was  $0.4 million, compared to  $4.4 million of benefits from the expiration of the statute of limitations at a foreign subsidiary and other discrete items in the prior year.

The Company's uncertain tax positions are affected by the tax years that are under audit or remain subject to examination by the relevant taxing authorities. The following tax years, in addition to the current year, remain subject to examination, at least for certain issues, by the major tax jurisdictions indicated:

 

 

 

Major Jurisdictions

 

Open Tax Years

Belgium

 

2005 through 2010

China

 

2000 through 2010

France

 

2008 through 2010

Germany

 

2004 through 2010

Italy

 

2003 through 2010

Japan

 

2009 through 2010

Mexico

 

2005 through 2010

Thailand

 

2005 through 2010

United Kingdom

 

2009 through 2010

United States

 

2007 through 2010

          At January 31, 2011, the total unrecognized tax benefits were  $18.7 million, and accrued interest and penalties on these unrecognized tax benefits were  $2.1 million. The Company recognizes interest accrued related to unrecognized tax benefits in income tax expense. If the Company were to prevail on all unrecognized tax benefits recorded, substantially all of the unrecognized tax benefits would benefit the effective tax rate. With an average statute of limitations of about 5 years, up to  $3.6 million of the unrecognized tax benefits could potentially reverse in the next 12 month period, unless extended by audit. It is possible that quicker than expected settlement of either current or future audits and disputes would cause additional reversals of previously recorded reserves in the next 12 month period. Currently, the Company has approximately  $0.9 million of unrecognized tax benefits that are in dispute with various taxing authorities related to transfer pricing and deductibility of expenses. Quantification of an estimated range and timing of future audit settlements cannot be made at this time.

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Restructuring and Asset Impairment
6 Months Ended
Jan. 31, 2011
Restructuring and Asset Impairment
Restructuring and Asset Impairment

Note P – Restructuring and Asset Impairment

          The following is a reconciliation of restructuring reserves (in thousands of dollars):

 

 

 

 

 

Balance at July 31, 2008

 

 $

 

Accruals for restructuring during the reporting period

 

 

17,755

 

Less settlements made during the period

 

 

(13,915

)

Balance at July 31, 2009

 

 $

3,840

 

Accruals for restructuring during the reporting period

 

 

10,165

 

Less settlements made during the period

 

 

(9,866

)

Balance at July 31, 2010

 

 $

4,139

 

Accruals for restructuring during the reporting period

 

 

759

 

Less settlements made during the period

 

 

(4,834

)

Balance at January 31, 2011

 

 $

64

 

The Company commenced certain restructuring actions in Fiscal 2009 in response to the dramatic downturn in the worldwide economy. The restructuring expenses in the first quarter of 2011 include employee severance costs for approximately five employees related to the completion of the Company's planned restructuring activities. The Company did not previously anticipate these additional charges in the first quarter of 2011. The Company did not incur any restructuring charges during the second quarter of 2011 and does not expect to incur additional restructuring charges during the remainder of Fiscal 2011. The remaining liability will be settled during Fiscal 2011.

          Fiscal 2010 included  $2.1 million in asset impairment costs related to the downsizing of a plant in Germany and  $8.1 million in employee severance costs related to the reduction in workforce of approximately 550 employees. Fiscal 2009 included  $17.4 million in employee severance costs related to the reduction in workforce of approximately 2,800 employees. In addition,  $0.4 million was incurred primarily for distribution center consolidation and production line transfers.

          Restructuring expense detail is summarized as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
January 31,

 

Six Months Ended
January 31,

 

 

 

2011

 

2010

 

2011

 

2010

 

Gross Margin

 

 $

 

 $

3,366

 

 $

20

 

 $

4,122

 

Operating expenses

 

 

 

 

1,720

 

 

739

 

 

2,228

 

Total restructuring expenses

 

 $

 

 $

5,086

 

 $

759

 

 $

6,350

 


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